There's More Upside in Germany

FOR INVESTORS WHO HAVE MISSED the upside in German equities since the start of 2010, here is some good news: It isn't too late to catch the wave.

That may sound a little odd. After all, German equities have outperformed many of their European rivals since the start of 2010, and some investors will be considering locking in gains, especially with more and more economists now factoring in the likelihood of a slowdown this year and in early 2011.

But there are reasons to be cautiously optimistic about the prospects for Germany, Europe's single largest economy, that lead many observers to think another dip wouldn't be as pronounced in Germany as in other economies.

For one thing, Germany has several advantages over European rivals. The last recession in that country was harsh, especially in the manufacturing sector, where capacity utilization fell sharply, so it is rebounding from a relatively low base. The economy has put in a stellar performance this year–gross domestic product grew 2.2% in the second quarter, the biggest jump in more than 20 years. Of course, that pace is unsustainable, but momentum remains strong despite the appetite for exports from emerging markets.

ANOTHER BONUS FOR GERMANY and its exporters has been the relative weakness of the euro, which has fallen about 10% in value against the dollar since the start of 2010, partly due to the ailing euro-zone economies, notably Greece. Low interest rates have also been a boon.

Michael Wasserman, investment manager at Scottish Widows Investment Partnership, says the performance of German stocks this year has been driven largely by the economy's exposure to export-related industries, but he adds: "With industrial orders on an upward trend and unemployment falling for the 14th consecutive month, even the domestic picture continued to brighten."

Following reports of second-quarter corporate results, German companies have enjoyed upgrades in earnings estimates for the full year averaging 6.8%, compared with 1.3% globally, says Deutsche Bank.

Those fundamentals are reflected in the Frankfurt benchmark DAX index, which has scratched out a gain of about 2% since Jan. 1, while other benchmark indexes over the same period are down about 1% in the U.K., 8% in France and 12% in Italy and in Spain.

Daimler should continue to benefit from growing emerging-markets demand for its cars from increasingly wealthy middle classes, while a strong recovery in truck sales in the U.S. bodes well, he says. Management's guidance doesn't look aggressive, he adds.

WASSERMAN POINTS TO HOCHTIEF'S pickup in orders and a strong order pipeline owing to strong demand for infrastructure investments in the Asia-Pacific region, where the company has exposure through its stake in the Australian construction company Leighton (LEI.Australia).

"Hochtief's current market capitalization is just equivalent to the value of its Leighton stake, implying zero value for its remaining operations, which is why this stock screens very attractive in terms of valuation," Wasserman adds.

Daimler's shares, which closed Friday at €41.7, ($53.74) have gained about 12% since the start of 2010, while those of Hochtief, which closed at €54.71, have gained about 2.17%.

Louise Kernohan, equities investment manager at Aberdeen Asset Management's Aberdeen Global European Equity Fund, also credits the leaner manufacturing base that came after Germany Inc. swallowed some bitter medicine to restructure during the recession. As a result, she says, "German companies are in good shape financially. Generally, they do have strong balance sheets."

She believes the industrial sector could do well in the months ahead, and her holdings include truck maker MAN SE (MAN.Germany), steel maker Thyssenkrupp (TKA.Germany), industrial-gas supplier Linde (LIN.Germany), cash-machine maker Wincor Nixdorf (WIN.Germany) and car maker BMW (BMW.Germany). The Aberdeen Global European Equity Fund is overweight Germany, with 16% of its assets allocated there.

Among Kernohan's picks, Thyssenkrupp is the only one that has underperformed the DAX this year, down approximately 14%. BMW and MAN are up about 38% and 32%, respectively, partly because the rebound in markets world-wide for luxury cars and heavy trucks lagged behind the recovery in demand for vehicles produced by mass-market car manufacturers.

If the macroeconomic conditions that helped the German market in the first half remain in place, Wasserman says, "we are optimistic to see German equities continue to outperform over the coming months and quarters."

On a Tear

European stocks rose sharply last week, with resource and auto stocks in the lead.

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